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Uncharitable Charities

Corporate Research E-Letter No. 61, September-October 2006

UNCHARITABLE CHARITIES: NON-PROFIT HOSPITALS ARE UNDER FIRE FOR MISTREATING THE UNINSURED

By Philip Mattera

As comprehensive healthcare reform has gone nowhere at the federal level, advocates for the uninsured and underinsured have targeted those portions of the private sector that prosper from the status quo: price-gouging pharmaceutical companies, for-profit hospital chains that defraud the Medicare system, heartless health insurance providers, and low-wage employers such as Wal-Mart that deny decent coverage to their workers and push them onto overburdened Medicaid rolls. Now another culprit is drawing fire: non-profit hospitals and health systems.

Tax-exempt hospitals, many of them sponsored by religious groups, are under attack as never before, accused of betraying their presumptive mission of serving the poor. The assault is coming from many directions. More than 500 hospitals are being investigated by the Internal Revenue Service to determine whether they are providing enough community benefits to justify keeping their exemption. Last month, the Senate Finance Committee held a hearing during which hospitals were raked over the coals. Even before the witnesses testified, Committee Chairman Charles Grassley, an Iowa Republican, put out a statement saying “non-profit doesn’t necessarily mean pro-poor patient” and suggesting their record “calls into question whether non-profit hospitals deserve the billions of dollars in tax breaks they receive.”

Pressure is also coming at the state and local levels. Attorneys general in states such as California, Ohio and Montana have been investigating the charity-care records of non-profit hospitals, while local property assessors are increasingly asking those institutions to justify their exemption from real estate taxes. Recently, the Illinois Department of Revenue upheld a decision to revoke the tax exemption of Provena Covenant Medical Center of Urbana, part of a six-hospital Catholic health system, because of an insufficient commitment to charity care.

At the same time, non-profit hospitals have been hit with a wave of class-action lawsuits brought on behalf of uninsured patients who say they were overcharged for services and then hounded when they were unable to pay their exorbitant bills. And in a move analogous to the “fair share” initiatives against Wal-Mart, a bill was introduced in the Illinois legislature earlier this year to require non-profit hospitals to devote at least 8 percent of their operating expenses to charity care. The odds are increasing that non-profit hospitals will have to make major changes in the way they operate.

LOWERING THE BAR

The definition of the charitable obligations of hospitals has been contested terrain for decades. Some of the earliest hospitals were indistinguishable from almshouses, serving mainly as repositories of the ailing poor—what historian Paul Starr called “places of dreaded impurity and exiled human wreckage.” The late 19th Century saw the rise of more professional institutions, which were divided between for-profit clinics set up by individual physicians with the backing of wealthy sponsors and “voluntary” hospitals supported by religious or philanthropic groups with charitable goals. Government-funded hospitals also grew in number, but at a much slower rate. It was not until much later that larger for-profit hospitals came on the scene, led by Hospital Corporation of America, which was founded in 1968. Today, non-profits make up about 60 percent of the country’s community hospitals, and many of them are affiliated with multi-billion-dollar healthcare systems.

For the first half of the 20th Century, larger hospitals were assumed to be focused on providing charity care, since few Americans had the means to pay for their own treatment. After the Second World War, Congress gave hospitals a financial boost with the passage of the Hill-Burton Act, which provided federal subsidies for the construction or modernization of healthcare facilities. In exchange, the institutions were supposed to provide a minimum level of charity care.

Nearly all non-profit hospitals were treated as tax-exempt at the local level, which excused them from paying property taxes, and at the federal level, which allowed them to avoid corporate income taxes, to solicit tax-deductible donations and to use tax-exempt bonds to finance their construction projects.

Yet tax-exempt status did not come automatically to non-profit hospitals. The IRS had to review each application on its own merits, which was made difficult by the fact that the Internal Revenue Code did not define “charitable.” To provide guidance, the IRS issued a Revenue Ruling (No. 56-185) in 1956. Among the criteria for exemption was that a hospital “must be operated to the extent of its financial ability for those not able to pay for the services rendered and not exclusively for those who are able and expected to pay.”

That principle remained in place for more than a decade, but in 1969—following the creation of the Medicare and Medicaid programs, which greatly expanded health coverage for low-income populations—the IRS drastically relaxed the requirements. The agency decided it was sufficient for a non-profit hospital to provide emergency care to indigent patients to retain its tax-exempt status. The obligation to provide other services without charge or at low cost was eliminated. The revenue ruling was challenged in court by the Eastern Kentucky Welfare Rights Organization, but in 1976 the Supreme Court found the group lacked legal standing. In 1983 even the emergency-room criterion was relaxed. Apparently, in the eyes of the IRS, it was enough for a non-profit hospital to simply be in the health business to qualify for an exemption. Apart from corporate structure, it became difficult to see what distinguished tax-exempt non-profit hospitals from taxable for-profit ones.

“BIG MONEY, TAX FREE, AND NO OVERSIGHT”

The tax status issue flared up in the early 1990s, amid concern over escalating health costs and the possibility that charity care for the rising number of uninsured families was falling victim to the cost-cutting efforts of hospitals. A May 1990 report by the General Accounting Office seemed to confirm those fears. The report found that non-profits were providing a smaller share of uncompensated care than their share of the overall market. In the wake of the report, there were Congressional hearings and proposed legislation but no lasting change at the federal level.

State and local officials were more aggressive, and a number of hospitals lost their exemption from property taxes. One of the larger institutions targeted was Methodist Hospital in Houston. Methodist ultimately kept its tax-exempt status by agreeing to a settlement with the state attorney general under which it greatly expanded its charity care and contributed millions to create an endowment for the indigent. The high-profile case prompted the Texas legislature to enact a law in 1993 that set strict charity-care requirements for all non-profit hospitals in the state.

The latest period of scrutiny of the hospital tax exemption began in 2004, with developments at both the state and federal levels. State action was concentrated in Illinois, where the Champaign County Board of Review and then the state Department of Revenue began the process of stripping Provena Covenant Medical Center of its tax exemption. In March 2004, Rep. William Thomas (R-Calif.), chair of the House Ways & Means Committee, announced that he intended to review the tax status of hospitals, suggesting they may be drifting away from their responsibility of serving the community. The Senate Finance Committee decided to hold hearings as well, with Chairman Grassley stating that “Big money, tax free, and no oversight have created a cesspool in too many cases.”

Joining these governmental initiatives were a spate of private lawsuits filed against non-profit hospitals. The plaintiffs’ lawyers, including tobacco litigation veteran Richard Scruggs, alleged that hospitals engaged in fraud, deceptive business practices and other offenses by overcharging uninsured patients and then hounding them when they were unable to pay their bills. The suits, originally brought against more than a dozen hospitals in various parts of the country, were intended to become a class action.

The initial defendants included a number of institutions that engaged in what could be called extravagant behavior. They included a Louisiana hospital that owns a luxury hotel, one in Georgia that flew its executives on private jets to meetings in the Cayman Islands, and Northern Mississippi Medical Center, which accumulated cash reserves of $300 million and enjoyed what one bond-rating agency called “exceptional profitability.”

The suits have had mixed results, especially in federal courts, where several judges ruled that a hospital’s tax-exempt status does not create a contract to provide charity care. On the other hand, plaintiffs’ lawyers have managed to secure some significant out-of-court settlements, especially on the West Coast. Last June, for instance, Catholic Healthcare West, the largest non-profit medical provider in California, agreed to a settlement that could provide hundreds of millions of dollars in refunds and bill adjustments to uninsured patients. Two months later, a similar settlement was reached with Sutter Health, a network of 26 hospitals in Northern California.

THE PATIENT-WORKER CONNECTION

Politicians, tax officials and plaintiffs’ lawyers are not the only thorns in the side of non-profit hospitals. They are also facing increasingly aggressive organizing drives among their employees led by labor groups such as the Service Employees International Union (SEIU). The unions, especially SEIU, deserve much of the credit for bringing the charity-care issue to the fore. Ever since SEIU began focusing its hospital organizing on non-profits in the late 1990s, the union has been making a connection between the failure to serve the uninsured and the failure to provide decent wages and working conditions to hospital employees.

In 1997 SEIU pressured state officials in California to review the tax status of the giant Sutter Health, which engaged in questionable deals and compensated its executives lavishly, all while providing a minimum of free or low-cost care for the uninsured. In 1999 the union released a report on the poor state of charity care at the Catholic Healthcare West conglomerate. In 2003 SEIU 1199 helped bring a suit against Yale-New Haven and Bridgeport hospitals in Connecticut on behalf of indigent patients who had their wages garnisheed and liens put on their homes because they couldn’t pay their bills. During the past two years, SEIU has pressed the charity-care issue against hospitals in states such as Ohio, Illinois, California and Oregon. It created a campaign website that critiques the operations of Providence Health & Services, a $6 billion non-profit based in Oregon. Most recently, SEIU United Healthcare Workers-West persuaded the assessor of California’s Contra Costa County to review the tax status of John Muir Medical Center because of its extensive involvement in for-profit ventures.

There is no evidence that Republican members of Congress, the IRS, trial lawyers and labor unions are colluding in a vast conspiracy against non-profit hospitals. They undoubtedly have varying motives for pressuring healthcare institutions over their charity record. Yet the sum of their efforts seems to be hastening the day when huge health empires will no longer be able to avoid both tax obligations and service to those most in need.